Impact of NPAs on Banks

An asset in any firm refers to its resources that hold a certain economic value, and that economic value can provide future benefit to the firm. Thus, according to RBI (Reserve Bank of India), for any asset on which the interest remains unpayable for a period of 90 days, the asset becomes non-performing. These non-performing assets decrease the profitability of banks in the country, as the bank gains a negative image and the account holders lose their trust in them. 

Globally, India ranks 5th in dealing with the NPAs. According to the surveys, the gross NPAs of the banking sector on June 30, 2018, were 11.52%, whereas, on March 31, 2018, the gross NPA was 11.68%. The NPAs on public sector banks in 2019 were approximately 7.3 trillion INR whereas, in 2021, it is approximately 6 trillion INR. Let’s study the causes of the rise in NPA, impacts on banks, and measures taken to reduce NPAs in detail.

Causes of Rising of NPAs in Indian Banks

• The economy of India was blooming in the early 2000s, due to which the banks provided a considerable amount of loans to businessmen and companies. However, these companies were not able to carry out their functions and were not able to pay their debts too. This led to the rising costs and recession of 2008.
• The relaxed lending norms to the corporate houses contribute greatly to the increase of NPAs in the banking sector. The banks provide unsecured loans without proper analysis and greatly contribute to the increase of NPA.
• There were bans on mining projects that greatly affected the industries such as the iron and steel sector. Their operating cost was higher than their income. Thus they were unable to pay back their loans to the banks. This mainly affects the public sector banks of India. The relaxed lending norms to the corporate houses contribute greatly to the increase of NPAs in the banking sector. The banks provide unsecured loans without proper analysis and greatly contribute to the increase of NPA.
• The priority sector lending contributes to the increment of NPA by giving loans for agriculture, education, MSMEs and Housing. The education loans alone contribute about 20% of the NPAs of the SBI.

Impact of NPAs on Banks

• The increase in NPAs reduces the profitability of the banks with its credibility. This NPA also harshly affects the capital base of the public sector banks. Due to the continuous rise of NPAs of any bank, the condition shall become chronic, and the banks might not be able to stabilise again.
• The account holders will lose their trust in the banks and may want to withdraw their money. This will hugely affect the banking system, and the bank might collapse. 
• As a result of high NPA, to increase the margin, the banks will be forced to decrease their interest rate on saving deposits. 

Thus, we can conclude that the high NPA on banks will negatively impact both the appearance and functioning of the banks.

Classification of NPAs

The banks classify NPAs into three primary categories; these are as follows:

1. Substandard assets: The asset that has been in the NPA for only 12 months or lesser; these types of assets are substandard assets.
2. Doubtful assets: Any asset that is in the state of non-performing for more than 12 months is a doubtful asset of NPAs.
3. Loss assets: The loss assets are the case of non-payment for a longer period. As the name suggests, the banks, auditors, or any inspector identifies the loans that will never be repaid and should be fully written off in such assets.

Strategies to Solve the Problem of NPAs in Banks

Several measures or strategies can be taken to solve the problem of NPA in banks and to increase the profitability of banks as follows:

• It is necessary to make senior executives of the company accountable for the lapses instead of the junior executives.
• There is a certain need for the betterment of corporate governance over the banks.
• The government should give the banks more authority to eradicate the problem of high NPAs.
• The Effective Management Information System (MIS) is a must to maintain effective credit risk management.
• To check the stressed assets, there should be the setting up of reconstruction companies.

Conclusion

NPAs or non-performing assets are those assets on which the interest remained unpaid for a period of 90 days. These non-performing assets negatively affect the functioning of the banks. It greatly reduces the profitability of banks and can also cause the collapse of the banking sector. Globally, India ranks 5th in dealing with the NPAs. There are several measures, such as making the senior executive accountable, proper governance, strict laws by the government etc., that can be implemented to eradicate the problem of NPA from the Indian banking sectors.